Permanent life insurance is a versatile financial product that helps protect your family while building cash value. However, not all permanent life insurance contracts work in quite the same way.
Participating life insurance, for example, may provide additional returns on your policy's cash value. The longer you own the policy, the more valuable this feature can become.
What Is a Participating Life Insurance Policy?
Participating life insurance is a policy that may pay dividends or bonuses if the insurer earns profits. These payments are typically annual but not guaranteed, as they depend on the company’s financial performance. Some insurers pay dividends regularly, while others may reduce or skip them during weaker years.
Only mutual insurance companies offer participating policies. Because they are owned by policyholders rather than shareholders, they may return profits through dividends, lower premiums, or both. Stock insurance companies do not pay dividends to policyholders.
Which Policies Can Receive Dividends
Not all permanent life insurance policies qualify for dividends.
| Policy Type | Eligible for Dividends |
|---|---|
| Participating whole life insurance | Yes |
| Non-participating whole life insurance | No |
| Term life insurance | No |
Term life insurance does not build cash value, which is why it does not pay dividends.
What to Review Before Buying
Before choosing a policy, confirm whether it is participating or non-participating. Dividends are not guaranteed, but reviewing a company’s history of dividend payments can help show how consistently it has shared profits and how it has performed over time.
How Do Participating Life Insurance Policies Work?
A participating life insurance policy provides guaranteed death benefit protection while also building cash value as you pay premiums. The insurer credits your cash value with a fixed interest rate based on conservative assumptions about investment returns and mortality expenses.
If the insurer earns more than expected after crediting guaranteed interest, it may pay a dividend. Dividend payments are not guaranteed and can change from year to year based on the company’s financial performance.
Dividend amounts are influenced by several factors:
- Investment performance: If invested assets earn more than projected, excess returns may contribute to dividends.
- Mortality risk: When fewer death benefit claims are paid than expected, insurers are more likely to generate profits.
- Operational expenses: Lower operating costs can improve profitability and support dividend payments.
At the end of each year, mutual insurance companies typically announce a dividend rate. Your dividend is based on your guaranteed cash value, minus fees, multiplied by the declared dividend rate.
Example: Jane has $100,000 in cash value at year-end. Her policy guarantees a 3% annual interest rate and declares a 2% dividend based on the insurer’s performance. As a result, her account earns $3,000 in interest and $2,000 in dividends.
How You Can Use Your Dividend Payment
If your participating policy pays a dividend, you typically have several options:
- Receive Cash: Dividends can be paid in cash, often tax free, by check or direct deposit. Funds can be saved or invested if not needed right away.
- Reduce premiums: Dividends may be applied toward premium payments, lowering out of pocket costs while keeping the policy active.
- Accumulate at Interest: Dividends can remain in the policy, increasing cash value and earning guaranteed interest.
- Buy Additional Insurance: Dividends may purchase paid up additions, increasing the death benefit without raising premiums.
- Pay Down Policy Loans: Dividends can reduce or repay outstanding policy loans, lowering interest costs and helping preserve the death benefit.
Participating vs. Non-Participating Life Insurance
Participating and non-participating policies differ in how profits are handled.
| Feature | Participating Policy | Non-Participating Policy |
|---|---|---|
| Dividend Payments | Possible but not guaranteed | None |
| Profit Distribution | Shared with policyholders | Retained by insurer |
| Cash Value Growth | Guaranteed interest plus potential dividends | Guaranteed interest only |
| Premium Cost | Typically higher | Typically lower |
Non-participating policies still provide a guaranteed death benefit and guaranteed cash value growth, but they do not offer dividends. Participating policies often cost more due to dividend potential, though annual dividends may help offset the difference over time.
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Pros: Benefits of Participating Life Insurance
All whole life insurance products potentially build cash value and guarantee a death benefit to help protect your loved ones. Participating whole life policies offer added advantages compared to non-dividend paying policies, such as:
- Potential for Larger Returns: Insurance companies are not required to pay dividends every year. However, choosing a carrier with a long history of dividend payments can help support returns above the guaranteed interest rate.
- Tax-Free Income: Dividends from a life insurance policy are generally not taxed unless they exceed the total amount you have paid into the policy. This differs from dividends paid to shareholders of publicly traded companies, which are typically taxable.
- Flexibility: You can use dividends in several ways, including taking the cash, paying premiums, or purchasing additional coverage. You can also adjust how dividends are used as your financial needs change.
Cons: Drawbacks of Participating Life Insurance
Participating whole life policies typically have higher premiums than non dividend paying policies. Cost is an important factor when choosing coverage.
While higher premiums may be worthwhile if dividends are paid consistently, there are tradeoffs to consider.
Potential drawbacks include:
- Higher premiums compared to non-participating or term policies
- Risk of forfeiting the policy if premium payments cannot be maintained
- Possible surrender charges if the policy is ended before enough cash value builds
Permanent life insurance is also more complex than term life insurance. Term coverage is generally less expensive and does not include cash value. Those who prefer a simpler option may choose term coverage and invest the savings separately.
Who Should Consider a Participating Life Insurance Policy?
A participating life insurance policy may be a good fit if you want lifelong coverage to help protect your spouse, children, or other dependents as long as premiums are paid. Because participating whole life insurance is permanent, the policy does not expire at a set date, which helps you avoid the need for future medical underwriting to replace coverage.
This type of policy may also appeal to individuals looking to grow assets while managing tax exposure. Key tax features include:
- Dividend distributions are generally tax free to policyholders.
- Policy withdrawals and loans are typically tax free up to the amount paid into the policy.
These benefits can be especially useful for individuals in higher tax brackets or those who have already reached contribution limits on tax advantaged retirement accounts.
Cost is another important factor. Whole life insurance is usually more expensive than term life insurance, and dividend paying policies often cost more than non-participating options. Participating whole life insurance may make sense only if you are confident you can continue paying the premiums over time.
Is a Participating Life Insurance Policy Right for You?
Participating life insurance policies may pay non-guaranteed dividends based on the company’s performance. These payments can offer added flexibility. You may take them as cash, apply them toward premiums, or use them to purchase additional coverage.
Still, dividends shouldn’t be the only factor when choosing a policy. It’s smart to review the insurer’s financial strength, claims-paying history, and pricing. A financial professional can help weigh the pros and cons and help ensure you choose coverage that fits your needs.
Conclusion
A participating life insurance policy can offer lifelong coverage along with the potential for dividends that add flexibility and long-term value. Still, dividends aren’t guaranteed, so weighing costs, company performance, and your ability to keep up with premiums matters. Taking time to compare options and talk with a financial professional can help you decide whether this type of policy fits your broader financial goals.
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